RBP Process

Overview

Most portfolio managers attempt to outperform a benchmark by picking winners. To do this they make educated guesses about the future fortunes’ of companies and we all know that by definition the future is completely unknowable. Paradoxically, the more they attempt to pick winners by trying to predict the unknowable future, the more they increase the likelihood of being wrong and investing in losers. At Guggenheim, we believe this introduces human behavioral biases that make such predictions very unreliable.

Our methodology, called the Required Business Performance®Methodology seeks to identify situations in which behavioral biases have pushed the stock price beyond management’s ability to deliver. It also potentially insulates us from behavioral biases when we make stock selections. We calculate the Required Business Performance®of each stock, then objectively calculate a probability that this performance will be delivered.

Can management deliver the Required Business Performance® to support the stock price?

Traditionally investors approach an investment decision from an “is it worth it” perspective”. We instead ask “What is the business performance required to support the stock at its current price” and “Can management deliver the Required Business Performance to support the stock price?”

We believe this tells us the likelihood behavioral biases have impacted the stock price. We believe that if, based on our analysis, management is likely to deliver; the stock is a worthy investment because its behavioral risk profile is attractive.

What is Required Business Performance®

A Logical Benchmark

Can management deliver the Required Business Performance®to support the stock price?

Required Business Performance®, or RBP®, is the revenue growth necessary to support the current stock price. Guggenheim recognizes that a company’s stock price implies certain business performance and uses its proprietary RBP®Methodology to determine each company’s Required Business Performance®. Next, using historical data, Guggenheim quantitatively determines the likelihood management will deliver the Required Business Performance®. We call this likelihood RBP®Probability, and we call the likelihood management will fail to deliver the Required Business Performance®the Behavioral Risk Indicator.

We believe stock prices are a reflection of the collective assumptions for future performance by investors. However we also believe these assumptions can become biased due to investors’ systematic behavioral biases, causing misalignment between stock prices and managements’ ability to deliver. We therefore feel that knowing how much revenue growth management must deliver to support the current stock price is critical to assessing the risk profile and relative attractiveness of stocks. This approach is the basis for used in our proprietary investment methodology.

Guggenheim’s RBP®Methodology aims to link a company’s current stock price to what its management does on a day-to-day basis and its ability to deliver in the future. We believe that investors’ systematic behavioral biases can affect stock prices causing a misalignment between the stock price and management’s ability and as a result we believe investors often unknowingly expose themselves to behavioral risk, which may hamper returns.

How We Calculate RBP®

Fact-Driven, Forecast-Free

Investment managers have traditionally focused on analytical valuation techniques based on the theory of discounted free cash flows (DCF). Such valuation models are designed to determine the intrinsic value of a stock, which can then be compared to the price of the stock for stock picking purposes. The essence of this valuation approach is a series of educated guesses or assumptions based upon management’s guidance regarding the growth of key business performance drivers specific to the company’s business model, which ultimately produces a highly subjective valuation of a company’s stock.

Although this method is fundamentally sound, we feel the subjectivity involved makes it unusable as a practical matter.

Instead, at Guggenheim, we reverse the traditional DCF method by starting with the value of a stock as determined by the market. Our methodology is a reverse discounted free cash flow analysis utilizing a company’s current stock price, its income statement, balance sheet and cash flow statements to determine what the current price of its stock implies about future free cash flow (FCF), revenue growth and RBP® . This process is fact driven forecast free and avoids the highly subjective process of forecasting the unknowable future.

RBP® Probability

A Powerful New Measure

The probability management will deliver the Required Business Performance to support the stock price is called RBP® Probability and some of our investment processes use this proprietary metric to select stocks. The RBP® Probability, provides us with an objective, disciplined, rules-based way of measuring management’s ability to deliver its Required Business Performance.

How We Calculate RBP® probability

To determine the RBP® Probability for a given company, we first determine the revenue growth required to support the current stock price. We do this using a reverse discounted cash flow model that uses the stock price as the input and then, assuming a ten-year first stage and perpetuity thereafter, solves for the required free cash flow and revenue growth rates.

Then, the company’s historical revenue growth rate is fit to a distribution curve using data from the prior twelve quarters. With this curve and the company’s required revenue growth rate, we can calculate the probability that management will deliver the required revenue growth.

In the hypothetical example below, the RBP® Probability is only 35%, indicating that based on management’s historical ability to deliver, there is only a 35% probability it will deliver its Required Business Performance® . This makes the company’s Behavioral Risk Indicator relatively high, 65%. At Guggenheim we seek to avoid companies with high behavioral risk such as this.

Behavioral Risk Indicator

A Risk Measure

The RBP® Probability tells us a probability that management will deliver the performance to support the stock price. The probability that management will not deliver the performance to support the stock price is also important. Behavioral biases can affect the assumptions that analysts and active managers use in their valuation models, causing prices to become misaligned with management’s ability to deliver. This may be an indication that behavioral biases have pushed the stock price to irrational levels and in such cases we feel that these stocks should be actively avoided.

The Behavioral Risk Indicator is defined as one minus the RBP® Probability. When this is very high, we feel that the revenue growth required to support the current stock price is not attainable given the company’s historical growth rates. This makes a purchase of the stock risky, but does not necessarily imply poor returns. Nevertheless, by avoiding this type of risk whenever possible, we believe we can achieve higher returns.

In the hypothetical example below, the RBP® Probability is only 35%, indicating that based on management’s historical ability to deliver, there is only a 35% probability it will deliver its Required Business Performance® . This makes the company’s Behavioral Risk Indicator relatively high, 65%. At Guggenheim we seek to avoid companies with high behavioral risk such as this.

RBP Funds

RBP® Probability cannot guarantee nor does it predict profit, performance or future stock prices. There is no assurance the RBP® methodology will successfully identify companies that will achieve their RBP® or outperform the performance of other indices.

These funds may not be suitable for all investors. Stock markets can be volatile. Investments in securities of small and medium capitalization companies may involve greater risk of loss and more abrupt fluctuations in market price than investments in larger companies. Unlike many investment companies, the funds are not “actively managed.” Therefore, the funds would not sell an equity security because the security’s issuer was in financial trouble unless that security is removed from its corresponding index. In addition, the funds' return may not match or achieve a high degree of correlation with the return of the index for a number of reasons. The indices are quantitative strategy indices, meaning that each fund invests in securities comprising an index created by a proprietary model. The success of each fund's principal investment strategy depends on the effectiveness of the model in screening securities for inclusion in its corresponding index. The factors used in the quantitative analysis and the weight placed on these factors may not be predictive of a security’s value. As a result, the funds' may have a lower return than if they were managed using a fundamental investment strategy or an index based strategy that did not incorporate quantitative analysis. A fund could become more volatile if its corresponding index concentrates on a particular sector. Please read the prospectus for more detailed information regarding these and other risks.

Transparent Value LLC, an affiliate of Guggenheim Partners, LLC, serves as the index provider for the indices utilizing the RBP Process.

Read a prospectus and summary prospectus (if available) carefully before investing. It contains the
investment objectives, risks, charges, expenses and other information, which should be considered carefully before
investing. To obtain a prospectus and summary prospectus (if available)
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